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Working Paper Series Department of Economics Alfred Lerner College of Business & Economics University of Delaware

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Working Paper Series Department of Economics Alfred Lerner College of Business & Economics University of Delaware Working Paper Series Department of Economics Alfred Lerner College of Business & Economics University of Delaware Working Paper No. 2004-07 The Constitutional Creation of a Common Currency in the U.S. 1748-1811: Monetary Stabilization Versus Merchant Rent Seeking. Farley Grubb FARLEY GRUBB THE CONSTITUTIONAL CREATION OF A COMMON CURRENCY IN THE U.S., 1748-1811: MONETARY STABILIZATION VERSUS MERCHANT RENT SEEKING The value of having a single currency, the optimal size of currency unions, and the cost of forming such unions, is an unresolved debate1. An important aspect of this debate is the empirical success claimed for currency unions such as the United States. The fact that otherwise-sovereign states within the United States are not legally allowed to issue their own currency, thus creating a single cur- rency zone for the whole United States based on the U.S. dollar, is commonly used as an example for emulation and as justification for policy choices, such as the current move toward a European currency union based on the Euro2. The benefits of this constitutionally created U.S. currency union and, by analogy, the benefits for other politically manufactured currency unions are as- sumed to be obvious, namely a reduction in monetary instability and exchange- rate transactions costs within the union thereby stimulating long-run economic growth. These alleged benefits for the U.S., however, are not derived from market evidence, but from simple theoretical assertions and from a historical literature that has taken as fact the rhetoric of the winning side at the U.S. Con- stitutional Convention. Independent of theory and rhetoric, little is known about how and why the U.S. currency union was created, and about how this 1 See Barry EICHENGREEN, European Monetary Unification, in: Journal of Economic Literature 31, Sept. 1993, pp. 1321-1357; Mathew FORSTATER, et al., Symposium: The European Economic and Monetary Union, in: Eastern Economic Journal 25, Winter 1999, pp. 31-115; Peter B. KENEN, et al., Common Currencies Versus Currency Areas, in: American Economic Review Papers and Proceedings 87, May 1997, pp. 211-229; Pablo Andres NEUMEYER, Currencies and the Allocation of Risk: The Welfare Effects of a Monetary Union, in: American Economic Review 88, Mar. 1998, pp. 246-259; Hugh ROCKOFF, How Long Did It Take the United States to Become an Optimal Currency Area?, in: NBER Historical Paper #124, April 2000, and the sources cited therein. The classic treatment is by Robert A. MUNDELL, A Theory of Optimum Currency Areas, in: American Economic Review 51, Sept. 1961, pp. 657-665; Robert A. MUNDELL, Uncommon Arguments for Common Currencies, in: Harry JOHNSON / Alexander SWOBODA (eds.), The Economics of Common Currencies, Cambridge, MA: Harvard Univ. Press 1973, pp. 114-132. 2 Recently some scholars have challenged the notion that the United States really achieved an optimal currency zone with its Constitutionally mandated currency union. See ROCKOFF, How Long Did It Take. 1 union performed in relation to the next best alternative. Even exactly when the U.S. dollar was adopted by market participants for private transactions is not known. These deficiencies are addressed here. Market-generated quantitative data on the choice of currency for spot transactions, the choice of currency for for- ward transactions, exchange rates by currency, and price indices by currency from 1748 through 1811 are used to determine when the transition from state- issued currency to the U.S. dollar occurred and to assess the non-wartime per- formance of prices, exchange rates, and purchasing power parity before versus after this transition. This evidence indicates that the formation of the U.S. cur- rency union had more to do with usurpation of state sovereignty for the per- sonal gain of merchant-bankers than with solutions to monetary instability and transaction costs within the union. A concise history of 18th-century American monetary regimes is provided first. Setting the Stage: 18th-Century American Monetary Regimes The British Crown did not permit its colonies to mint coins or establish banks, nor did it permit its coins to be exported from England3. The North American 3 The summary in this section is derived from Ben BAACK, Forging a Nation State: The Continental Congress and the Financing of the War of American Independence, in: Economic History Review 54, Nov. 2001, pp. 639-656; Thomas Senior BERRY, Western Prices Before 1861, Cambridge, MA: Harvard Univ. Press 1943, pp. 357-405; Hillman Metcalf BISHOP, Why Rhode Island Opposed the Federal Constitution, in: Rhode Island History 8, Jan. 1949, pp. 1-10; Apr. 1949, pp. 33-44; July 1949, pp. 85-95; Oct. 1949, pp. 115-126; Terry BOUTON, Tying Up the Revolution: Money, Power, and the Regulation in Pennsylvania, 1765-1800, unpublished Ph.D. Thesis, Duke Univ., 1996; Leslie V. BROCK, The Currency of the American Colonies, 1700-1764, New York: Arno Press 1975; Charles W. CALOMIRIS, Institutional Failure, Monetary Scarcity, and the Depreciation of the Continental, in: Journal of Economic History 48, Mar. 1988, pp. 47- 68; David Jack COWEN, The Origins and Economic Impact of the First Bank of the United States, 1791-1797, New York: Garland 2000; Joseph Albert ERNST, Money and Politics in America, 1755-1775, Chapel Hill, NC: Univ. of North Carolina Press 1973; James E. FERGUSON, The Power of the Purse, Chapel Hill, NC: Univ. of North Carolina Press 1961; Farley GRUBB, The Circulating Medium of Exchange in Colonial Pennsylvania, 1729-1775: New Estimates of Monetary Composition, Performance, and Economic Growth, in: Explorations in Economic History, 2004, forthcoming; Farley GRUBB, Two Theories of Money Reconciled: The Colonial Puzzle Revisited with New Evidence, unpublished working paper, Economics Dept., Univ. of Delaware, 2002; Bray HAMMOND, Banks and Politics in America, Princeton, NJ: Princeton University Press, 1957, pp. 3-226; A. Barton HEPBURN, A History of Currency in the United States, New 2 colonies imported foreign coins through their trade surplus with the Caribbean and Southern Europe. Much of this specie, however, was re-exported, largely as a result of the mercantile policies that held the colonies in a chronic current- accounts trade deficit with the mother country. Colonists constantly com- plained that they lacked a sufficient circulating medium of exchange, especially with which to pay taxes, since taxes could not be paid through merchant-store book credit or with barter goods. Initially, some colonies allowed non-specie York: Augustus M. Kelly, Revised and Enlarged Edn. 1967, pp. 1-87; Merrill JENSEN (ed.), The Documentary History of the Ratification of the Constitution, Volumes 1-3, Madison, WI: State Historical Society of Wisconsin 1976-1978; Edward S. KAPLAN, The Bank of the United States and the American Economy, Westport, CT: Greenwood Press 1999; Donald L. KEMMERER, The Colonial Loan-Office System in New Jersey, in: Journal of Political Economy 47, Dec. 1939, pp. 867-874; Richard LESTER, Currency Issues to Overcome Depression in Pennsylvania, 1723 and 1729, in: Journal of Political Economy 46, June 1938, pp. 324-375; Richard LESTER, Currency Issues to Overcome Depressions in Delaware, New Jersey, New York, and Maryland, 1715-37, in: Journal of Political Economy 47, Apr. 1939, pp. 182-217; John J. MCCUSKER, Money and Exchange in Europe and America, 1600-1775, Chapel Hill, NC: Univ. of North Carolina Press 1978; Samuel MCKEE JR. (ed.), Papers on Public Credit, Commerce and Finance by Alexander Hamilton, New York: Columbia Univ. Press 1934; Margaret Ellen NEWELL, From Dependency to Independence, Ithaca, NY: Cornell Univ. Press 1998; Eric P. NEWMAN, The Early Paper Money of America, Iola, WI: Krause Publications, 4th edn., 1997; Arthur NUSSBAUM, A History of the Dollar, New York: Columbia Univ. Press 1957; Lawrence H. OFFICER, Between the Dollar-Sterling Gold Points, New York: Cambridge Univ. Press 1996; Edwin J. PERKINS, Conflicting Views on Fiat Currency: Britain and its North American Colonies in the Eighteenth Century, in: Business History 33, July 1991, pp. 8-30; Edwin J. PERKINS, American Public Finance and Financial Services, 1700-1815, Columbus, Ohio: Ohio State Univ. Press 1994; B. U. RATCHFORD, American State Debts, Durham, NC: Duke University Press 1941, pp. 9- 72; Sidney RATNER / James H. SOLTOW / Richard SYLLA, The Evolution of the American Economy, New York: Basic Books 1979, pp. 82-99; Anna Jacobson SCHWARTZ, The Beginning of Competitive Banking in Philadelphia, 1782-1809, in: Journal of Political Economy 55, Oct. 1947, pp. 417-431; Bruce SMITH, American Colonial Monetary Regimes: The Failure of the Quantity Theory and Some Evidence in Favor of an Alternative View, in: Canadian Journal of Economics 18, Aug. 1985, pp. 531- 565; Bruce SMITH, Some Colonial Evidence on Two Theories of Money: Maryland and the Carolinas, in: Journal of Political Economy 93, Dec. 1985, pp. 1178-1211; Clarence L. VER STEEG, Robert Morris, Revolutionary Financier, New York: Octagon Books 1976; Gary M. WALTON / Hugh ROCKOFF, History of the American Economy, New York: Dryden Press, Eighth Edn. 1998, pp. 79-89; Elmus WICKER, Colonial Monetary Standards Contrasted: Evidence from the Seven Years’ War, in: Journal of Economic History 45, Dec. 1985, pp. 869-884; Janet WILSON, The Bank of North America and Pennsylvania Politics: 1781-1787, in: Pennsylvania Magazine of History and Biography 66, Jan. 1942, pp. 3-28, and the sources cited therein. 3 commodity monies, such as paper tobacco contracts or tobacco leaf, to fill this void. In 1690 Massachusetts issued small-denomination bills of credit (paper money) to its soldiers participating in King William’s War. These bills could be used to pay taxes levied by Massachusetts and began to circulate as a medium of exchange within the colony. Soon thereafter other colonies adopted this in- novation, e.g., South Carolina in 1703, New York and New Jersey in 1709, Rhode Island in 1710, North Carolina in 1712, Pennsylvania in 1723, Maryland in 1733, Georgia in 1735, and the last being Virginia in 1755.
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